The longer you are in business, the more valuable rich financial reporting becomes.
In the early days, it’s about getting proof of concept, getting customers in the door and making enough money to ensure survival. As a business matures, continuing that approach will limit the business’s potential, and it will be very stressful to be a part of.
The challenge is that there’s so much going on in a business, how do you work out what’s valuable to report on and what’s just noise?
In order to grow, you need to be able to identify the profit pockets and the profits leaks. The pockets tell you where you make your money and the leaks tell you where you lose or make very little of it.
By identifying these pockets, you can build a strategy to bottle your way of doing things and begin to truly scale.
Equally as valuable is to identify the leaks – those profit and energy suckers that you can have the relieving feeling of either reducing or cutting out altogether. After all, no business successfully scales by doing more and more of something that loses money.
Operational finance is the measuring and improvement of the profit drivers in your business. Your management accounts will tell you the business’ financial performance and position overall [LINK to Management Accounts blog above] but in order to truly understand what’s going on beneath the surface, you need deeper insights into these drivers to see what’s pulling the numbers up and what’s dragging them down.
Usually, it’s better to run your operational finance reports over a quarter. A single month of data will not give as many telling insights because there’s simply not enough data to draw comprehensive conclusions.
Your Operational Finance Reports should cover the following:
Revenue by Client – showing each client contribution to the overall revenue and the % reliance on the biggest spending clients
Profit per client – showing each client’s contribution to covering the businesses running costs and EBIT
Profit per Fee Earner – showing the contribution that each fee earning member of the team makes to covering the businesses running costs and EBIT
Profit per Project – showing the performance on each project vs what was planned in the initial quoting
Departmental Profit & Loss – showing the contribution that each department or service makes to covering the businesses running costs and EBIT
Reliance on big spending clients remains a key issue for agencies for two reasons:
They are often unprofitable since your team feel an obligation to put in the extra hours for them
One day they will no longer ask for your service and that lost revenue leaves a gap on your business, which means you are carrying a lot of risks which impacts your overall stress levels and the saleability of your company
You really want to avoid any client representing more than 15% of your annual turnover. Anything bigger than that and it’s likely that your profit margin will be wiped out when you lose them, and you might well have to cut some of your team too.
Profit per client
Showing each client’s contribution to covering the businesses running costs and EBIT
As much as you might love what you do, you can’t be serving low-profit clients. They drain your business’s resources and it’s a difficult situation to break out of if it starts to become the norm.
Low profit on clients means one of three things:
They are high maintenance which has a huge impact on your team’s morale
The work was underpriced for the scope involved
Your team are inefficient at delivering, highlighting skill shortages or worse – a poor working attitude
As well as driving short term profit for the business, there is another fundamental reason why having profitable clients is important – and that is that it breathes a successful culture across your business. There is nothing more demoralising than slogging away day after day to see that it is all for nothing. Your business has had no reward if it’s not covered its costs and you have been unable to demonstrate value to your client (they’ve just paid your costs which they could have done with a bunch of freelancers, not the margin on top that they wanted to pay to have it all taken care of by a professional agency. In other words, you have not proven to yourself that you have added value.
Profit per Fee Earner
Showing each fee earning staff members contribution to covering the businesses running costs and EBIT
In business, you have two types of people that you employ – those that deliver fee-earning work and those that don’t (support). The fee earners need to bring in enough revenue to cover their cost, the cost of the support staff and all of the other running costs of the business. Measuring the profit of each fee earner is not just about judging their individual performance (the work might not be there for them to do if the sales machine hasn’t worked), it’s about seeing the essential economics – you can’t run a business where it’s costing you more to employ people than they are earning you.
To work out the required profit for each of your fee earners, use this Profit Maximiser Tool [LINK to Profit Maximiser Tool].
Profit per Project
Showing the actual profitability of each project, relative to the estimated profit
When you quote for a project, you scope it out, price it and give the client a proposal. Once it’s signed you have to deliver the outcomes that you have contracted to deliver.
Profit can, therefore, be lost due to any of the following reasons:
Under-pricing in the proposal: If the price you have quoted for doesn’t correlate with the cost + margin required to deliver the agreed scope then your team are fighting a losing battle before they have even started
Inefficient delivery: If your team take longer to deliver the project and it’s on a fixed fee promise then you lose profit on the extra hours that you have been unable to bill to the client. What’s more, the client is also frustrated that the job took longer if it means you missed the agreed deadline!
Sope creep: Scope creep hs the same implications as inefficient delivery but instead of being caused by inefficient, its the result of allowing the team to add more and more specification to the project without it being priced up and agreed.
To work out the required profit for each of your projects, use this Project Wash Up form.
Departmental Profit & Loss
Showing the actual profitability of each department, to covering the businesses running costs and EBIT
Most agencies will be split into departments of some sort – grouped by services such as Paid Search, SEO and Creative or by Teams, Pods or Squads with skills that cut across multiple services and serve a portfolio of clients.
Breaking your operations down into these departments allows you to see the performance of smaller sections of your business and to gains insights into where it’s working and what needs to improve.
I don’t usually advise trying to apportion every overhead to a department, just those that are directly associated with the revenue that that department is responsible for, such as staff, outsourced freelance/agency support, client on-costs, etc. That will give you the contribution of each department and you can deduct the central overheads to get the company EBIT.
If you use Xero payroll, you can set the employees settings up so that their cost is apportioned to their relevant department. You can do the same for other costs that you get billed for from your suppliers.
Where it all falls down
Getting any of this to work hinges on the quality of your company’s time tracking. If the team are not consistently recording all of their time and doing it accurately, then you will never be able to present the facts about what’s happening within your business. Time recording is one of the most common frustrations for agency owners because you do all the work to figure out what you should be reporting on and you know the importance of seeing this information but then the laxness of your team getting their timesheets in leads to it all falling down. The reality is that no-one enjoys keeping timesheets and they never will, so getting them to do it is a big project to take on and someone will have to give full attention to making it happen, to avoid your continued frustration.
Bringing this level of reporting into your business elevates the company into a true commercial entity. You will be able to make decisions about what’s right for the medium and long term strategy of the business and where to focus your time.